The working capital requirement of a concern depends upon a large number of factors such as nature and size of business, the character of their operations, the length of production cycles, the rate of stock turnover and the state of the economic situation.
It is not possible to rank them because all such factors of different importance and the influence of individual factors change for firm over time. However, the following are important factors generally influencing the working capital requirement.
Table of Contents
Factors Influencing Working Capital Requirement
- Nature of Business
- Size of Business
- Production Policy
- Manufacturing process
- Seasonal Variation
- Rate of stock turnover
- Credit policy
- Business Cycle
- Rate of growth of business
- Price Level Changes
Nature of Business
The working capital requirement of a firm basically depends upon the nature of this business. Public utility undertakings like electricity water supply and railways need very limited working capital because they offer cash sales only and supply services, not products and as such, no funds are tied up in inventories and receivables.
Generally speaking, it may be said that public utility undertakings require a small amount of working capital, trading and financial firms require a relatively very large amount, whereas manufacturing undertakings require sizable working capital between these two extremes.
Size of Business
The working capital requirement of concern is directly influenced by the size of its business which may be measured in terms of the scale of operations.
In certain industries, the demand is subject to wide fluctuations due to seasonal variations. The requirements of working capital in such cases depend upon the production policy.
In a manufacturing business, the requirement of working capital increases in direct proportion of the length of the manufacturing process. Longer the process period of manufacture, larger is the amount of working capital required.
In certain industries raw material is not available throughout the year. They have to buy raw materials in bulk during the season to ensure an uninterrupted flow and process them during the entire year.
Rate of stock turnover
There is a high degree of inverse co-relationship between the quantum of working capital; and the velocity or speed with which the sales are affected. A firm having a high rate of stock turnover will need lower amount of working capital as compared to affirm, having a low rate of turnover.
The credit policy of concern in its dealing with debtors and creditors influence considerably the requirement of working capital. A concern that purchases its requirement on credit and sell its products/ services on cash require lesser amount of working capital.
Business cycle refers to alternate expansion and contraction in general business activity. In a period of boom i.e., when the business is prosperous, there is a need of larger amount of working capital due to increase in sales, rise in prices, optimistic expansion of business contracts sales decline, difficulties are faced in collection from debtors and firms may have a large amount of working capital lying idle.
Rate of growth of business
The working capital requirement of a concerning increase with the growth and expansion of its business activities. Although it is difficult to determine the relationship between the growth in the volume of business and the growth in the working capital of a business, yet it may be concluded that of a normal rate of expansion in the volume of business, we may have retained profits to provide for more working capital but in fast growth in concern, we shall require a larger amount of working capital.
Price Level Changes
Changes in the price level also effect the working capital requirement. Generally the rising prices will require the firm to maintain larger amount of working capital as more funds will be required to maintain the same current assets.